To what extent do financing constraints, herding behavior and ownership affect firms’ innovation activities? Evidence from China

Abstract

Maintaining high economic growth rate is arguable the central challenge for China’s macroeconomic policy in the coming decade. The development of innovation, especially in business sectors, is critical for China to meet that challenge. Therefore, it is important to understand the innovation activities in Chinese enterprises. However, due to high adjustment costs and the high uncertainty of innovation activities, innovative firms generally suffer more from asymmetric information than their counterparts who do not engage in innovation activities, which cause lending bias and herding behavior in the market. In addition, because of “political pecking order” in China, firm with different ownership (state-owned, foreign-owned, private-owned, and collective-owned) will behave differently and their ownership level will also directly and indirectly affect firms’ innovation activities.

This thesis, using the firm-level data from the NBS (National Bureau of Statistics of China) over the period 2000−2007, investigates the effects of financial constraints, herding behavior, and various ownerships on firms’ innovation activities form both macroeconomics and microeconomics perspectives.

Specifically, the first empirical chapter of this thesis investigates the extent to which financing constraints affect the innovation activities. Based on a variety of specifications and estimation methods, we document that Chinese firms’ innovation activities are constrained by the availability of internal finance. Specifically, private firms suffer the most, followed by foreign firms, while state-owned and collective enterprises are the least constrained. Moreover, the availability of internal finance represents a particularly binding constraint on the innovation activities of small firms, located in the coastal provinces, with low political affiliation, and fewer state shares, as well as for sole proprietorship firms.

Next, Chapter Four investigates the extent to which Chinese firms display herding behavior in their innovation activities, and then assess the impact of this behavior on corporate productivity. Based on a variety of different specifications, we find strong evidence in favor of herding in Chinese firms’ innovation activities. In particular, private, small firms, with no political affiliation are more likely to herd. We also find that innovation herding has a negative effect on productivity.

The final empirical chapter of this thesis investigates the extent to which state and foreign ownership affect firms’ innovation activities. We firstly find a significant positive effect of joint ventures on innovation activity. Moreover, our results display an inverse U-shaped relationship between state ownership and product innovation. Foreign-affiliated firms, especially foreign-affiliated joint-venture firms, are more likely to innovate than domestic firms, but their innovation propensity and intensity both diminish as foreign ownership increases. We also report strong evidence that, conditional on absorptive capacity, the relationship between foreign ownership and product innovation becomes positive for foreign-affiliated joint-venture firms.